Whether you’re a farmer or a small business owner, thinking about how to protect yourself and your assets from liability is an important component of planning for the longevity of your business. We’ve tackled why to form an entity in several blog posts (check out our entity formation blog posts: here), but now we want to dive into creating and separating multiple entities or different types of assets.
We know, we know, you’re just feeling comfortable with forming one entity, why would you need MORE THAN ONE? Well, because sometimes you want to separate different types of liability and assets so that the risk of one does not affect the assets of the other. So in this blog post, we’re going to break down why, especially when it comes to land or property, it may be smart to keep your business separate from your real estate and maybe even use separate entities.
Let’s use a scenario - say you’re a farmer and you’re about to buy some new land, or inherit some land from your family, and then you’re looking to start a vegetable farm and CSA (community supported agriculture). In this situation, it may be best to either a) form separate entities for the land and the farm business or b) keep the land in your personal name but form a separate entity for your farm business. Why? Because if something goes south with the farm business whether it is debt (so long as you don’t put the property up as collateral), liability that your insurance doesn’t cover, or other risks, then only your farm business entity is subject to the risk of loss, and not your land. And we all know for farmers land is everything!
If you set up two entities it really keeps any personal assets you have from being at risk because whether your farm business is sued or your land LLC, you personally, are protected (remember insurance is always the first line of defense but we’re always a fan of building layers of protection).
The same is true even if you aren’t a farm business. If you are a small business that buys a building for your brick and mortar or office, separating the real estate from your business is important for the same reasons as detailed above. It’s also especially helpful if you may be renting part of the building to another business, or if down the road you close your brick and mortar business but rent the location to a new storefront.
So separating these liabilities can be a great tool for building another layer of protection for your business and personal assets and limiting risk and loss. However, there are some important considerations when deciding if this is the right approach for you. These are:
If you’re buying land or property, then setting up the separate entity ahead of time is important. If you wait until after you have purchased the real estate, then you may be subject to transfer tax because you would be transferring the real estate from you personally to a different entity (even if you own that entity). If you already have property and want to separate liability but don’t want to pay transfer tax, that is ok, you can still create separation through separating your business’s entity from the property by owning the property personally.
You need a lease. Whether you keep the land in your name or hold it in a separate entity you need to make sure you have a clear lease between the land entity or holder and your business entity. Remember - it’s not separate unless you actually separate it! (This seems obvious but it’s important to make sure you’re actually doing it.! The lease also needs to be “legit.” It should be written, your business should be paying reasonable rent (not just like $1), and you need to follow its terms (which entity is paying for the taxes, utilities, etc.).
You need to keep the money separate. Similar to having a lease, you need to make sure the money stays separate too. The business entity needs to pay rent from the business account and the money needs to go into either the property entity account or your personal account. It is a business deduction to the business entity and income to you or your property entity. Same thing goes with the utilities and taxes - make sure they are coming from the right accounts in accordance to how these are divvied up in the lease.
Make sure the right entities are on the right documents for example, insurance (the individual entities may both need insurance), leases, invoices, etc.
If you look at this and say, that’s way more administrative stuff than I want to handle or I’ve already not done these things, that’s ok. It may make sense for you to keep the property and business all under one entity, or it may make sense to implement these things now if you can. For example: you own your farm and business all under a sole proprietorship and now you want to form an LLC for the business. So, you keep the farm under your name and then we draw up a lease between the two.
And remember, this is just another layer of protection, not the only one. If you have good insurance, a lower risk business, or other measures in place, then you may decide this option isn’t for you. But if you’re looking into property or have property and a business, separating the two may be worth exploring!
DISCLAIMER: This blog post is meant for informational purposes only and does not constitute specific legal advice or create an attorney-client relationship. Readers should discuss their specific situation with an attorney.